What is Short Selling?

Amiel Low, '24

Short-selling has become a buzzword in the financial world in recent years. Short-selling is an investment strategy that enables people to bet against the value of a stock, anticipating that the price of the stock will decrease. Shortsellers and investors have opposing market expectations- the investor expects a stock to increase in price, while the short-seller expects the stock to decrease in price Therefore their success is inversely related because when one succeeds, the other one experiences losses Short-selling is a very controversial practice and can be as profitable an investment as a risky one

In practice, short-sellers borrow shares of a company from one person and sell those same shares to another person If the price of the stock decreases, the shortseller makes a profit, but if the price of the stock increases, the short-seller loses money. To explain why, let’s use an example. Suppose Ilan is a short-seller and borrows 10 shares of Tesla from Jeremy at $100 a share (once Ilan borrows 10 shares of Tesla, he owes Jeremy 10 shares of Tesla regardless of the price). After borrowing the shares from Jeremy, Ilan meets with Josh and sells him the 10 shares for $100 a share (receiving $1000) Imagine that the next day, Ilan wakes up and sees that Tesla stock has decreased to $50 a share Ilan can then buy 10 shares at $50 a share ($500 total) and then go back to Jeremy and give him back the 10 shares of Tesla that he owes him By doing so, Ilan makes a profit because he sold $1000 worth of shares to Josh and paid Jeremy only $500 worth of shares

This may seem like an easy way to make money, but the risks that come with short-selling are severe Suppose that the stock that Ilan borrowed from Jeremy increased to $150, then Ilan would owe Jeremy $1500 worth of stocks (Ilan would lose money because he only received $1000 for the shares and is now paying $1500 to Jeremy) At first, short-selling may seem no riskier than simply buying a stock However, shortselling is riskier because the potential loss is unlimited compared to the finite loss present in buying a stock. This is true because when buying a stock, one could only lose what he invested because the lowest a stock can go is $0. However, when short-selling, the price the stock can reach is unbound, and therefore, the loss could theoretically be infinite.

In addition to being risky, shortselling is a controversial topic for several different reasons Firstly, many debate the ethical side of profiting off of a company’s downfall; when shortselling, one is essentially investing with the hopes that a company will fail. Secondly, some short-sellers are linked to market manipulation by spreading misinformation about a company with the hopes that its stock price will drop. In conclusion, short-selling is a legal yet very controversial practice that can yield great profit with the potential of generating unlimited losses.